Report

Equity Volatility Term Premia

Abstract: This paper estimates the term-structure of volatility risk premia for the stock market. Realized variance term premia are increasing in systematic risk and predict variance swap returns. Implied volatility term premia are decreasing in risk initially, but then increase at a lag, predicting VIX futures returns. By modeling the logarithm of realized variance, the paper derives a closed-form relationship between the prices of variance swaps and VIX futures. The model provides accurate pricing and highlights periods of dislocation between the index options and VIX futures markets. Term premia account for a significant fraction of the variation in long-maturity claims.

Keywords: options; variance risk premium; variance swaps; term structures; return predictability; VIX futures;

JEL Classification: C58; G12; G13;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2018-09-01

Number: 867

Note: Revised December 2020. Previous title: “Relative Pricing and Risk Premia in Equity Volatility Markets”